Why Indian businesses don't create enough jobs

jobsVivek Kaul
Neelkanth Mishra, the India Equity Strategist for Credit Suisse, has written a very interesting column in today’s edition (August 6,2013) of The Indian Express. In this column Mishra writes “It shocks most people to hear that India had 42 million enterprises in 2005, but that’s what the Economic Census found. This is when, even as late as 2012, India had less than a million companies.”
What this means is that the average business in India is very small in size. “In 2005, each enterprise on average employed a shockingly low 2.4 people. Almost 40 per cent of the enterprises were in trade (retail, wholesale, or repair of motor vehicles), with average employment of 1.7 people! Truly mom & pop, father & son, and one-man enterprises (the statisticians have a better name for them: “Own Account Enterprises”). Even in manufacturing, which is 20 per cent of all enterprises, the average employment is merely three,” writes Mishra.
Given this small size of Indian businesses, the salaried class still forms a small proportion of the population. As
the Report on Employment and Unemployment Survey 2011-2012 “In the rural areas, 11.1 per cent households are estimated to be having regular/wage salary earning as major source of income. In the urban areas, 42.3 per cent households are estimated to be having regular wage/salary earnings as major source of income.”
The report also found that “50.8 per cent or majority of the households are found to be having self employment as the major source of income.” Not surprising, given that small firms cannot create jobs and thus people have to fend for themselves.
These numbers need to be read along with the numbers and arguments provided by economists Jagdish Bhagwati and Arvind Panagariya in their book
India’s Tryst with Destiny – Debunking Myths that Undermine Progress and Addressing New Challenges. As they write “The number of workers in all private-sector establishments with ten or more workers rose from 7.7 million in 1990-91 to just 9.8 million in 2007-2008. Employment in private-sector manufacturing establishments of ten workers or more, however, rose from 4.5 million to only 5 million over the same period. This small change has taken place against the backdrop of a much larger number of more than 10 million workers joining the workforce every year.”
What all these numbers clearly tell us is that Indian businesses have not been able to create enough jobs. And this explains to a large extent why 50.8 per cent of households are self employed.
A major reason for the lack of creation of jobs is the fact that an average Indian business was and continues to be very small. As Bhagwati and Panagariya write “employment in India is heavily concentrated in the small enterprises. While the large enterprises have some presence, the medium size enterprises are entirely missing.”
Research and data prove this point even more conclusively. “An astonishing 84 per cent of the workers in all manufacturing in India were employed in firms with forty-nine or less workers in 2005. Large firms, defined as those employing 200 or more workers, accounted for only 10.5 percent of manufacturing workforce. In contrast, small- and large-scale firms employed 25 and 52 per cent of the workers respectively in China in the same year,” write Bhagwati and Panagariya.
What is true about manufacturing as a whole is also true about apparels in particular,which is highly a labour intensive sector. 92.4% of the workers in this sector work with small firms which have forty-nine or less workers. Now compare this to China where large and medium firms make up around 87.7% of the employment in the apparel sector.
This leads to poor performance on the export front as well. “The near absence of medium and large firms in apparel, especially when compared with China, is clearly linked to the poor performance of this sector. The inability to massively capture the export markets in this major sector with comparative advantage is linked to the poor performance of labour-intensive manufacturing and, therefore manufacturing in general. The ultimate reason why growth has not been as inclusive in India as in South Korea,Taiwan and China remains the absence of large-scale firms in labour-intensive sectors in India,” write Bhagwati and Panagariya.
This lack of inclusive growth comes from the tendency of Indian businesses to remain small. Since businesses continue to remain small they do not generate as many jobs as they could. Ultimately, maximum jobs in any economy are created when small firms graduate to becoming medium firms and then finally large firms.
This really hasn’t happened in the labour-intensive manufacturing sector in India. The labour intensive sectors of manufacturing accounted for around 12.94% of the gross value added in the organised manufacturing in 1990-1991. This number rose to 15.9% in 2000-01 and then fell back to 12.91% in 2003-04. “And, in all likelihood,this share has further declined since 2003-04. In fact, some of the fastest growing industries between 2003-04 and 2010-11have been automobiles, two- and three-wheelers, petroleum refining, engineering goods, telecommunications, pharmaceuticals, finance and software. All these sectors are either capital intensive or skilled-labour intensive,” write the authors.
A major reason behind businesses in labour intensive sectors continuing to remain small are the labour laws. Labour comes under the Concurrent list of the Indian constitution, meaning both the state government as well as the central government can formulate laws in this area. “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra(the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them,” write Bhagwati and Panagariya.
And the presence of these ‘burdensome’ labour laws explains to a large extent why entrepreneurs in labour intensive sectors like apparel, where labour costs account for 80 per cent of the total costs, choose to remain small. As Bhagwati and Panagariya write “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws”.
The authors recount an interesting story told to them by economist Ajay Shah. Shah, it seems asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already making yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws”.
There is a problem and there is a solution. But every time there is some talk about labour reforms being reformed, political parties (almost every one of which has a labour union) start protesting. But what they don’t realise is that by protesting they essentially ensure that firms in labour intensive sectors continue to remain small. And that means creation of fewer ‘new’ jobs.
The article originally appeared on www.firstpost.com on August 7, 2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek)